Software as a Service (SaaS) is a relatively new but thriving industry. This industry has been led by companies such as Salesforce.com, SuccessFactors and RightNow Technologies (the latter two recently acquired by SAP and Oracle, respectively). Much of their success can be attributed to the unique business model associated with SaaS. This uniqueness is reflected in their new financial language and acronyms. Even though the concepts are not new, the way they are applied can help you view and understand your business in a way that can, in turn, help you experience explosive growth.
The key is in understanding the difference between “customer value” and “cash flow”. Customer value measures sales/growth success, while cash flow measures what you can re-invest.
Listed here are 6 key SaaS metrics:
- CAC – Customer Acquisition Cost
- TCV – Total Contract Value (Bookings)
- CLTV – Customer Lifetime Value
- ACV – Annual Contract Value
- MRE – Monthly Recurring Expense
- MRR – Monthly Recurring Revenue
- CMRR – Contracted Monthly Recurring Revenue
These metrics can be applied to almost any business with a little creativity. When applied, you can drive growth like that of Salesforce.com, SuccessFactors and Google, among others. I will define and explain how to use each of these metrics:
CAC – Customer Acquisition Cost – (Customer Value Metric)
What is it? – CAC is the total sales and marketing expense associated with acquiring a single customer. These expenses should include both variable and fully burdened fixed costs (including sales/marketing salaries, commissions, overhead, etc).
What does it mean? – CAC should be used to analyze and compare the value of the customer vs the cost. Your CAC should be between 30% and 100% of your annual revenue associated with the customer (the lower CAC ratio is, the better).
TCV – Total Contract Value (Bookings) – (Customer Value Metric)
What is it? – TCV is the total sales number committed in the contract or service order by the customer. For example, if a customer contracts 24 months at $6,000/month, plus $25,000 of professional services, the TCV is equal to $169,000 = (($6,000 x 24) + $25,000).
What does it mean? – This is the measure of initial customer value. This number is most commonly used to pay commissions, build internal support/processes/systems and project infrastructure/product delivery needs. This metric is your crystal ball into your future, enabling you to manage operational requirements without overspending or under-resourcing as you grow your customer base.
CLTV – Customer Lifetime Value – (Customer Value Metric)
What is it? – CLTV is the total revenue that a customer will pay your company until they stop purchasing, renewing, or using your products or services. CLTV is similar to TCV with the addition of projected growth, contract renewals, and additional purchases from a customer. For example, if a customer contracts a 24-month agreement with an initial TCV of $169,000, then is projected to add 50% to the contract in the initial term, you can anticipate an initial term value of $253,500 ( $169,000 + $84,500). If the customer is expected to renew for an additional 2-year term at the increased contract value ($253,500), and grow an additional 25% during the second term, the CLTV would be $633,750 ($253,500 + 253,500 + (253,500 * .25%) = $633,750).
What does it mean? – Assuming your goal is growth, a good guideline is that your CLTV should be 3 or more times greater than your CAC (higher is better). A common mistake is to measure your CAC against TCV, a much more conservative measure of profitability, than CLTV. To understand and use CLTV effectively, you must truly understand your customer, their attrition rates and upsale/downsale patterns–otherwise you can get yourself into trouble.
ACV – Annual Contract Value – (Customer Value Metric)
What is it? – ACV is the annual revenue paid to your company by a specific customer, regardless of multi-year contracts. ACV would be identical to TCV if your contract term was 1 year.
What does it mean? – If you do not have a good sense of customer retention and growth rates, ACV should be used instead of TCV to pay commissions, build internal support/processes/systems and project infrastructure/product delivery needs. It is also a great metric to measure and trend annual growth numbers.
MRE – Monthly Recurring Expense – (Cash Management Metric)
What is it? – MRE is the anticipated recurring expenses including payroll, services, facilities, materials, depreciation and all other operating expenses that can be assigned to a given month. This metric measures the predictable monthly expense. (NOTE: MRE is not a traditional SaaS metric because most SaaS companies are venture backed and therefore have an “unlimited” access to cash through multiple rounds of investment. However, if you intend to apply these other metrics to a non-SaaS company with limited resources, you must incorporate MRE into your financial analysis metrics.)
What does it mean? – MRE is an expense management tool. It tells you what your monthly spend is anticipated to be. It is different than a cash analysis because it is based on committed expenses, not spent cash. Use it to compare to MRR (see below) for short term spend decisions. The anticipated difference between the two gives you insight into investments that can be made to support short-term growth opportunities. Looking into your TCV growth, you can spend cash that you will earn within the next three months with a very high degree of accuracy without risking your business – You can spend your TCV growth today.
MRR – Monthly Recurring Revenue – (Cash Management Metric)
What is it? – MRR applies to products and services that have a monthly cost associated with the contract. This metric measures predictable monthly revenue regardless of contract commitment.
What does it mean? – MRR is a cash management tool that can be used to understand and predict cash flow. When you know exactly what to expect from MRR, you can make aggressive purchasing decisions . However, to use this effectively, you must carefully understand growth and attrition trends in relation to your MRR. In the early stages of a company, MRR is a safer metric to use for sales compensation to prevent the spending of money you may not have or collect, because continued customer purchasing may not highly predictable, yet.
CMRR – Contracted Monthly Recurring Revenue – (Cash Management Metric)
What is it? – CMRR is exactly like MRR but is the subset of MRR that measures only the MRR that is bound by a contract.
What does it mean? – This is ultimately what you should be driving towards in order to increase your insight and visibility to future cash flow. As you build your business around CMRR, you can build a “Just In Time” business model, turning marginal increase in CMRR, coupled with marginal decrease in MRE, into increased revenue.
Use these metrics to drive explosive growth
Explosive growth is achieved by hiring sales people and acquiring product resources, not as CMRR is acquired, but by anticipating predictable revenue through the analysis of all of your key growth ratios and the management of MRE, thereby leveraging your sales just as banks and investment professionals leverage their money, but without the risk. You can spend the money because you know you are going to get it.
It’s all about forecasting and short-term decision making. These two categories of metrics give two different outlook perspectives.
- Customer Value Metrics = Long-term outlook of today’s performance. Use these metrics to manage long term strategic and growth decisions (hiring plan, investment strategy, forecasting, etc) and to build your company’s strategy.
- Cash Flow Metrics = Short-term outlook of yesterday’s performance. Use these metrics to make immediate, aggressive operational decisions (hiring, short-term investment, strategy adjustment, etc). Use them to execute operationally; to tell you if you can execute to or in excess of your strategic plan determined by your Customer Value Metrics.
Track all your metrics, build your strategy, execute and adjust like the high growth SaaS companies do and you can build a similar growth trajectory.
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